Hungary kicks off new monetary easing cycle

Hungary kicked off a new monetary policy easing cycle on March 24 as it cut its benchmark by 15bp to a record low of 1.95% and flagged that more loosening is on the way to fight deflation.

The monetary policy council of Hungary's Magyar Nemzeti Bank (MNB) was widely expected to return to easing this month after an eight-month hiatus. The country has had deep and prolonged deflation on the back of the plunge in oil prices and cuts in household energy bills.

The MNB had strongly hinted it would cut rates in March to accompany its updated inflation report, although a slight pullback in deflationary forces both at home and across the Eurozone had cast some doubt over the move. With oil prices looking to have stabilised and analysts suggesting deflation may have peaked in the Eurozone, inflation was slightly better than expected in February, albeit it still sank to -1.0%.

However, with the additional momentum of the ECB's QE programme driving currencies and yields, the market largely bet on a rate cut. The rate cut was slightly smaller than the 20bp reduction expected by economists polled by Portfolio.hu.

“Given the modest nature of today’s cut, we suspect that a few more small reductions may follow,” Capital Economics wrote in a note. Analysts at Erste see the main rate going down to 1.5% by the end of the second quarter.

Reflecting the conflicting forces pulling across the EU, the forint reacted to the cut by rising. The currency traded at 301.9 against the euro just after 2pm Budapest time, stronger than the 303.47 before the announcement, according to Reuters.

The MNB also appeared to leave little doubt that it plans to offer more easing in the coming months. In a statement following the rate decision, the bank said that “cautious easing of monetary conditions may continue as long as it supports the achievement of the medium-term inflation target”.

However, the extent of the cycle will likely remain pinned to inflation. The MNB announced new CPI and GDP projections as part of its March Inflation Report, which is scheduled for release on March 26. The bank cut this year’s inflation forecast to 0% from 0.9% expected in December. For next year the bank sees average inflation at 2.6%, down from December’s projection of 2.9%.

“If a CPI forecast below 2% for 2016 is predicted, a dovish mood in the monetary council may prevail. If the forecast exceeds 2% Y/Y, we expect that a more cautious and more gradual rate cut cycle may be implemented,” KBC suggested ahead of the announcement.

The bank said it expects inflation to rise close to its 3% target at the end of 2017. The bank also assigned a tolerance range of plus/minus 1pp to its 3% medium-term inflation target.

"It’s tricky to know how far the MPC will cut rates from here on," admits William Jackson at Capital Economics, "but with inflation set to remain negative until at least the summer, there seems to be scope for at least two or three reductions."

Regarding expected economic growth, the MNB turned more upbeat, projecting 3.2% growth for 2015 and 2.5% for 2016, higher than previous forecasts of 2.3% and 2.1%.

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